In this paper, I investigate the development and determinants of CDS spreads for 18 major European banks between December 2001 and January 2004 using daily data. I demonstrate that two nonstationary common factors can be extracted from the data that together explain most CDS spread variation across time and across banks. The group of German banks plus a few Southern-European banks appear to systematically have high CDS spreads and to be relatively sensitive to changes in the underlying factors. The dominating first common factor impacts on all banks in a similar direction, suggesting strong market integration. However, the quantitatively less important second factor has opposite effects on credit spreads of Southern European versus Northern European banks, suggesting some remaining country-specific or region-specific credit risk. Finally, I show that the first common factor may indeed be interpreted as a measure of market conditions as it is cointegrated with the European P/E ratio and the 2-year nominal interest rate
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Houweling, P. & Vorst, A.C.F., 2002.
"An Empirical Comparison of Default Swap Pricing Models,"
Research Paper
ERS-2002-23-F&A Revision_, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
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